This past quarter, the Financial Accounting Standards Board (FASB) has issued one new accounting standard update (ASU) and the Government Accounting Standards Board (GASB) issued three Statements. The latest issue of the Rundown features a summary and important details pertaining to these new standards. In addition, we highlight a standard that is not yet effective but that clarifies existing guidance and should be considered by certain private entities that issue instruments potentially settleable in the entity’s stock which could result in some private entity instruments that were previously not classified as a liability and/or remeasured subsequently at fair value to be classified as a liability and remeasured subsequently at fair value which could result in restatements and/or costly valuations. Next, we highlight the importance of and provide tips for identifying embedded leases for governments. Lastly, we have put together a list of standards that are effective for upcoming reporting periods. To learn more, read our full issue now.
Second Quarter 2022 Accounting Standard Updates
Newly Issued:
During the second quarter 2022, the Financial Accounting Standards Board (FASB) issued one new accounting standard update (ASU) and the Government Accounting Standards Board (GASB) issued three. A brief summary of these standards follows:
Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions
The amendments in this Update clarify that if an equity security has contractual sale restrictions, this is not to be considered part of the unit of account and is therefore not considered when measuring the security’s fair value. This amendment does not change current GAAP, but rather clarifies those principles when measuring fair value and reduces the diversity in practice.
Disclosure Changes:
The amendments in this Update requires an entity who holds equity securities subject to contractual sale restrictions to disclose the following:
- The fair value of equity securities subject to contractual sale restrictions reflected in the balance sheet
- The nature and remaining duration of the restriction(s)
- The circumstances that could cause a lapse in the restriction(s)
Effective Date and Transition Requirements:
Public business entities: For fiscal years beginning after December 15, 2023, including interim periods within those fiscal years.
All other entities: For fiscal years beginning after December 15, 2024, including interim periods within those fiscal years.
Early adoption is permitted for both interim and annual financial statements that have not yet been issued.
Investment company under Topic 946: The amendments in this Update should be applied to those applicable equity securities executed or modified on or after the date of adoption. Those equity securities executed before the date of adoption should continue to be accounted for under the accounting policy applied before the adoption of the amendments until the contractual restrictions expire or are modified.
All other entities: The amendments in this Update should be applied prospectively, with any adjustments recognized in earnings and disclosed.
Statement No. 99 of the Governmental Accounting Standards Board Omnibus 2022
GASB 99
The omnibus statement contains several technical corrections to improve consistency by addressing (1) practice issues that have been identified from previous GASB Statements, and (2) adding guidance on accounting and financial reporting for financial guarantees. Some of the more impactful changes are as follows:
- An entity that extends an exchange or exchange-like financial guarantee should recognize a liability and expense related to the guarantee when qualitative factors and historical data indicate that is it more than likely not a government will be required to make a payment related to the guarantee. Special assessment debt, financial guarantee contracts within the scope of Statement 53, or guarantees related to conduit debt obligations are excluded.
- Changes in the fair value of “other derivative instruments” should be reported on the “resource flows statement” separately from the investment revenue classification, information should be disclosed in the notes to financial statements separately from hedging instruments and investment derivative instruments, and governments should disclose the fair values of derivative instruments that were reclassified from hedging derivative instruments to “other derivative instruments.”
- Several clarifications related to leases under GASB 87 related to the impact termination and purchase options have on the lease term. Lessee and lessor recognition and measurement for leases other than short-term leases that also transfer ownership has been clarified, and lease incentives has been further defined.
- Certain clarifications related to Public-Private and Public-Public Partnerships (PPPs) including PPP terms, receivables for installment payments and for the underlying asset from the transferor’s perspective, and liability for installment payments and deferred outflow of resources from the operator’s perspective.
- Clarifications related to Subscription-Based Information Technology Arrangements (SBITAs) as it relates to options to terminate, short-term SBITAs, and measurement of subscription liabilities.
- Replaces the original deadline for using the London Interbank Offered Rate (LIBOR) as a benchmark interest rate for hedges of interest rate risk of taxable debt, with a deadline of when LIBOR ceases to be determined by the ICE Benchmark Administration using the methodology in place as of Dec. 31, 2021.
- State governments should recognize Supplemental Nutrition Assistance Program (SNAP) distributions as a nonexchange transaction.
- Requirement to disclose the measurement of attribute(s) applied to nonmonetary transactions rather than basis of accounting for those assets.
- In blended financial statements, whenever a primary government pledges revenue for a debt-issuing component unit, the primary government should reclassify an amount due to the component as an interfund payable and an interfund transfer out simultaneously with the recognition of the revenues that are pledged.
- Reiterates that there should be a total government-wide column within the MD&A, Statement of Net Position, and Statement of Activities excluding all fiduciary activities and custodial funds.
Effective Date and Transition Requirements:
- Items 6, 7, 8, 9, and 10 above are effective upon issuance (April 2022).
- Items 3, 4, 5 above are effective for fiscal years starting after June 15, 2022.
- Items 1 and 2 above are effective for fiscal years starting after June 15, 2023.
Early adoption is encouraged and is allowed by individual topics so long as all the requirements associated with an individual topic are implemented together.
Statement No. 100 of the Governmental Accounting Standards Board Accounting Changes and Error Corrections – an amendment of GASB Statement No. 62
GASB 100
The Statement prescribes the accounting and financial reporting for accounting changes and error corrections as follows:
- The Statement defines accounting changesas changes in accounting principles, changes in accounting estimates, and changes to or within the financial reporting entity. For (1) certain changes in accounting principles and (2) certain changes in accounting estimates that result from a change in measurement methodology, a new principle or methodology should be justified on the basis that it is preferable to the principle or methodology used before the change. That preferability should be based on the qualitative characteristics of financial reporting such as understandability, reliability, relevance, timeliness, consistency, and comparability. The Statement also addresses corrections of errors in previously issued financial statements.
- Changes in accounting principles and error corrections should be reported retroactively by restating prior periods.
- Changes to or within the financial reporting entity should be reported by adjusting beginning balances of the current period.
- Changes in accounting estimates should be reported prospectively by recognizing the change in the current period.
- If a new pronouncement does not contain specific transition provisions, then the requirements of this Statement for changes in accounting principles should be applied when implementing the new pronouncement.
- The aggregate amount of adjustments to and restatements of beginning net position, fund balance, or fund net position, as applicable, should be displayed by reporting unit. In addition, information about the quantitative effects on beginning balances of each accounting change and error correction should be disclosed by reporting unit in a tabular format and reconciled to the beginning balances as previously reported to the restated beginning balances.
- Descriptive information about accounting changes and error corrections, such as their nature should be disclosed.
- For periods that are earlier than those included in the basic financial statements, information presented in required supplementary information (RSI) and supplementary information (SI) should be restated for error corrections, if practicable, but not for changes in accounting principles.
GASB 100 is effective for accounting changes and error corrections made in fiscal years beginning after June 15, 2023. Early adoption is encouraged.
Statement No. 101 of the Governmental Accounting Standards Board Compensated Absences
GASB 101
Liabilities for compensated absences should be recognized for (1) leave that has not been used and (2) leave that has been used but not yet paid in cash or settled through noncash means. A liability should be recognized for leave that has not been used if (a) the leave is attributable to services already rendered, (b) the leave accumulates, and (c) the leave is more likely than not to be used for time off or otherwise paid in cash or settled through noncash means. In estimating whether the leave is more likely than not to be used or otherwise paid or settled, a government should consider relevant factors such as employment policies related to compensated absences and historical information about the use or payment of compensated absences. However, leave that is more likely than not to be settled through conversion to defined benefit postemployment benefits should not be included in a liability for compensated absences. In addition, certain types of compensated absences (parental, military and jury duty) should be not recognized until the leave occurs. If leave is required to be accrued, it should generally be measured using an employee’s pay rate as of the date of the financial statements.
Governments are now allowed to disclose only the net change in the compensated absences liability as long as they identify it as a net change. In addition, governments are no longer required to disclose which governmental funds typically have been used to liquidate the liability for compensated absences.
GASB 101 is effective for fiscal years beginning after December 15, 2023. Early adoption is encouraged.
Private Entities: An ASU Not Yet Effective, But That You Should Consider
Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity
Adoption of this amendment will simplify the accounting associated with certain financial instruments with characteristics of both liabilities and equity and amends certain disclosure requirements. The Update reduces the number of accounting models available for convertible debt instruments and convertible preferred stock, which is aimed to result in fewer embedded conversion features being separately recognized from the host contract when compared to current GAAP. Additionally, the Update makes certain changes to EPS guidance.
Entities that will see the most impact from early adopting are those who:
- Hold convertible instruments with beneficial conversion or cash conversion features.
- Hold contracts in their own equity, specifically freestanding instruments and embedded features that are accounted for currently as derivative liabilities.
Specifically, for entities that hold contracts in their own equity, the ASU removes the following conditions that were required for equity classification:
- Settlement must be in unregistered shares
- There is no requirement in the contract to post collateral.
- No counterparty rights rank higher than shareholder rights
IMPORTANT: For some private entities, the most consequential but easily overlooked impact of this ASU is that it clarifies that all financial instruments that are freestanding and potentially settleable in an entity’s own stock are required to be assessed under ASC 815-40 Contracts in Entity’s Own Equity, regardless of whether the instrument has all the characteristics of a derivative instrument. Some private entities have taken the view that because their stock is not actively traded (i.e., “readily convertible into cash”) any instrument potentially settleable in their stock did not meet the net settlement criterion required under the definition of a derivative. Thus, any such instrument would not have to be analyzed under ASC 815-40 at all or that if the instrument were analyzed under ASC 815-40 and found to not meet the equity classification criteria, it would not be subsequently remeasured at fair value like other derivative liabilities because it did not meet the definition of a derivative. This ASU clarifies that any freestanding instrument, regardless of whether the instrument would meet the definition of a derivative, must be assed under ASC 815-40 and if found to either not be considered indexed to the entity’s own stock or not meet the equity classification criteria, then said instrument must be classified as a liability a remeasured at fair value at each reporting period.
This concern was explicitly mentioned in Basis for Conclusions paragraph 103 as follows:
“A few comment letter respondents observed that the fair value requirement may include contracts that were previously not measured at fair value. The Board acknowledges that because of a lack of guidance, there may be a population of these instruments that are currently being accounted for at cost and, therefore, an entity should transition to fair value measurement under the amendments in this Update. The Board concluded that this amendment mostly affects freestanding instruments issued by private companies. For example, a freestanding warrant on the share of a private company may not meet the definition of a derivative because it requires physical settlement or cannot be net settled because the underlying equity is not readily convertible to cash.”
This clarification could result in some private entity instruments that were previously not classified as a liability and/or remeasured subsequently at fair value to be classified as a liability and remeasured subsequently at fair value. This could result in restatements and/or costly valuations of those private entities.
This ASU is effective for private entities, including publicly traded smaller reporting companies, for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is allowed, however, all private entities, regardless of whether they early adopt this ASU or not, should consider this ASU’s clarification that freestanding instruments potentially settleable in an entity’s own stock are required to be assessed under ASC 815-40 Contracts in Entity’s Own Equity, regardless of whether the instrument has all the characteristics of a derivative instrument. Entities may adopt this ASU using either a full retrospective or modified retrospective approach.
Governments: Don’t Forget About Embedded Leases in Service Contracts
Under legacy lease accounting guidance, service contracts that contained embedded leases were often treated the same as service contracts without an embedded lease. This was because there often was no substantive difference in accounting, so governments did not invest the resources to identify and separately account for embedded leases. As a result of GASB 87, governments are now required to record a lease asset and lease liability. To avoid misstatements under GASB 87, it is important for entities to identify whether contracts contain an embedded lease. If so, they must bifurcate the contract into lease and non-lease components.
There are some important differences between ASC 842 and GASB 87 that could result in more embedded leases for governments than their commercial counterparts. First, under GASB lease agreements can have interruption in usage. An organization must only obtain the present service capacity during the period of use, not uninterrupted control of the asset. Second, GASB allows for substitution rights whereas under FASB substitution rights might preclude the existence of a lease if the substitution right is practical and the supplier would benefit economically from substituting the underlying asset.
Service contracts are the most likely to contain an embedded lease. For example, a transportation service contract may require the supplier to use a specific truck. Or for example, if your organization has a security services contract that includes hardware, and the contract lists each item with specific identification number. Logistics, transportation, warehousing, and data center service contracts are among the most common places to look for embedded leases.
Service contracts usually do not contain the terms “lease,” or “rent,” making the process of identifying embedded leases more difficult. One way to conduct a review of potential embedded leases is to coordinate among the various business units or departments, such as Purchasing and Procurement, depending on the extent of decentralization of the contract process. Then analyze payments made to outside vendors such as service contracts and search those vendor contracts. Search for language such as “exclusive use,” “solely,” “identification number,” etc.
Newly Effective Standards:
Calendar Year-end Public Companies
As a reminder, the following ASUs are effective for public companies for calendar year 2022:
- ASU 2020-06: Debt-Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging-Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity
- ASU 2020-07: Not-for-Profit Entities (Topic 958)-Presentation and Disclosures by Not-for-Profit Entities for Contributed Nonfinancial Assets
- ASU 2021-01: Reference Rate Reform (Topic 848): Scope
- ASU 2021-04: Earnings Per Share (Topic 260), Debt—Modifications and Extinguishments (Subtopic 470-50), Compensation—Stock Compensation (Topic 718), and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options (a consensus of the FASB Emerging Issues Task Force)
- ASU 2021-05: Leases (Topic 842): Lessors—Certain Leases with Variable Lease Payments
- ASU 2021-10: Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance
Calendar Year-end Private Companies
As a reminder, the following ASUs are effective for private companies for calendar year 2022:
- ASU 2016-02: Leases (Topic 842)
- ASU 2018-01: Leases (Topic 842)-Land Easement Practical Expedient for Transition to Topic 842
- ASU 2018-10: Codification Improvements to Topic 842, Leases
- ASU 2018-11: Leases (Topic 842)-Targeted Improvements
- ASU 2018-14: Compensation-Retirement Benefits-Defined Benefit Plans-General (Subtopic 715-20): Disclosure Framework-Changes to the Disclosure Requirements for Defined Benefit Plans
- ASU 2018-20: Leases (Topic 842)-Narrow-Scope Improvements for Lessors
- ASU 2019-01: Leases (Topic 842): Codification Improvements
- ASU 2019-12: Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes
- ASU 2020-01: Investments-Equity Securities (Topic 321), Investments-Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815): Clarifying the Interactions between Topic 321, Topic 323, and Topic 815 (a consensus of the Emerging Issues Task Force)
- ASU 2020-05: Revenue from Contracts with Customers (Topic 606) and Leases (Topic 842): Effective Dates for Certain Entities
- ASU 2020-07: Not-for-Profit Entities (Topic 958)-Presentation and Disclosures by Not-for-Profit Entities for Contributed Nonfinancial Assets
- ASU 2020-08: Codification Improvements to Subtopic 310-20, Receivables—Nonrefundable Fees and Other Costs
- ASU 2020-10: Codification Improvements
- ASU 2021-04: Earnings Per Share (Topic 260), Debt—Modifications and Extinguishments (Subtopic 470-50), Compensation—Stock Compensation (Topic 718), and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options (a consensus of the FASB Emerging Issues Task Force)
- ASU 2021-05: Leases (Topic 842): Lessors—Certain Leases with Variable Lease Payments
- ASU 2021-07: Compensation—Stock Compensation (Topic 718): Determining the Current Price of an Underlying Share for Equity-Classified Share-Based Awards (a consensus of the Private Company Council)
- ASU 2021-10: Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance
Governmental Entities
As a reminder, the following GASB is effective for governmental entities for the upcoming June 30, 2022 year-ends:
- GASB Statement 87: Leases
